State of the CARS Rule, Part 3

I’ve spilled a lot of ink this year discussing the CARS Rule and what it could mean for retail automobile dealers. It is altogether fitting and proper that I should do this, for its impact on the dealership community will be significant. But it will also have significant impact on other participants in the automotive ecosystem, principally on finance sources and F&I product providers and administrators. It is of this impact I now write.

First, let’s consider the rule’s potential impact on finance sources, those banks or captive finance companies that purchase dealerships’ retail installment sale contracts, or RISCs, and consumer leases. This “indirect lending” funding process is the lifeblood of the retail automotive industry. RISCs and consumer leases are negotiable instruments, meaning they can be transferred from one entity to another for value.

In the retail automotive context, the selling or leasing dealership is the original creditor. Then the dealership cashes the contract by selling it to a finance source at a discount. The dealership gets cash, and the finance source gains an asset. The dealership pays off the floorplan and some other bills, buys more inventory, and the process repeats itself. Everybody wins. What could possibly go wrong?

Lots, actually, or I wouldn’t have my current job. Say a customer has a claim against a dealership under the CARS Rule. The customer may demand monetary damages from the dealership. The dealership may tell the customer to pound sand (politely, of course). What’s the aggrieved customer to do?

One option is to sue the finance source that’s holding the RISC or lease. There is a Federal Trade Commission mandate called the “Holder in Due Course Rule.” This regulation, formally called "Preservation of Consumers' Claims and Defenses, Unfair Or Deceptive Acts Or Practices," dictates that any consumer credit contract must include a specific notice that subjects any holder of the contract to all claims and defenses which the debtor could assert against the seller of goods or services.

In plain English, this means that, under the CARS Rule, or any other law, for that matter, a customer could sue a bank for the sins of the dealership. But the CARS Rule is of particular concern because it explicitly redefines many existing shortcomings as deceptive trade practices. What if a customer’s data is lost in a dealership data breach? If the dealership did not follow the Safeguards Rule but its privacy policy notice said it did (and they do), that is a deceptive trade practice and nothing a bank wants to defend.

Couldn’t the bank avoid this headache by reassigning the RISC or lease back to the dealership? Sorry, but it doesn’t work that way.

While consumers don’t have the right to assess fines like the FTC does, their attorneys will be sure to point to the nominal fine amount of $51,744 per violation as a fine estimate of damages. In short, finance sources’ potential liability will go up at the same time the threshold of grievance goes down. No bueno. What’s the aggrieved bank to do? This is where the F&I product providers and administrators can lend a hand. One new area of potential liability is proving “express, informed consent.” Product providers could modify their contract forms to more clearly demonstrate that customers knew exactly what they were buying and that it was optional.

Going further, product providers could insert mandatory mediation language in their contracts as a prerequisite for mandatory arbitration. Courts often find reasons to throw out mandatory arbitration clauses, but I am aware of no court that has ever tossed a mediation clause. Mediation is far cheaper and quicker than arbitration or litigation and creates an environment in which a dealership can both repair the customer relationship and avoid the costs of either.

There is more to discuss on this topic, but space here is limited. The main takeaway is that the CARS Rule will gore more oxen than just dealerships, and the players in our industry should coordinate their responses. It is in the dealerships’ best interest to comply with the rule in the first instance so it doesn’t create Holder in Due Course Rule liability for finance sources. It is in the best interest of finance sources to fund only F&I product contracts that extend some protection to them. It is in F&I product providers’ best interest to craft contract forms that better support and document dealership compliance.

Compliance is a team sport.

James Ganther is president of Mosaic Compliance Services.